Gaps between the Cup and the Lip

Banking scenario

Dr B K Mukhopadhyay

(The author, a noted management economist and an international commentator on ongoing business and economic affairs, can be contacted at m.bibhas@gmail.com)

The warning bell has been sounded. The global banking sector is approaching the end of the cycle in less than ideal health, with nearly 60 percent of banks printing returns below the cost of equity.

As the banking industry enters a period of profound and probably difficult change, the world’s banks face a tidal wave of post-crisis regulatory initiatives and restructuring. But new pressures also bring new ideas and new opportunities. The fast (and of course consistent) changing situation must be fully made use of. The crisis showed deep failures in banks’ risk management — putting banks, regulators and governments under pressure to change operating codes. Compliance costs will rise, but the new standards are invigorating some businesses.

Is the current going that good?

In its latest global banking review, McKinsey & Company assessed that nearly 60 percent of the world’s banks need to make changes or they’ll struggle during the next downturn. The consultancy firm warned that banks were increasingly vulnerable as they’re not growing as quickly.

The analysis rightly diagnosed that banks aren’t investing enough to stay competitive with newer rivals either. More and more clients are trusting big technology companies such as Amazon and Google to handle their financial needs, yet banks spend only 35 percent of their budget on innovation compared with 70 percent by fintechs. It also warned that a business model could offset other advantages. For example, it said, a broker-dealer with scale and the right location that operates in the securities space — where margins and volumes have fallen sharply in recent years — “still doesn’t earn the cost of capital.”

The expert analyst is clear: “…many banks face greater risks due to geography, scale, differentiation, and business mode. American banks’, for example, returns are 10 percentage points higher than those of their European peers. Bigger banks generate stronger returns than smaller ones, whether across a country, a region, or a client segment”.

“A decade on from the global financial crisis, signs that the banking industry has entered the late phase of the economic cycle are clear: growth in volumes and top-line revenues is slowing, with loan growth of just 4 percent in 2018 — the lowest in the past five years and a good 150 basis points (bps) below nominal GDP growth,” McKinsey said. It also highlighted banks’ depressed returns on equity, which haven’t risen in line with their costs. Investor confidence in banks was waning.

Developing Block: A force to reckon with

It is a well known fact that the developing world’s banking sector of late has been attracting global attention because of its proud plumage and performance — striving to reach global customers and achieve standards for a global presence — an impeccable achievement of having our wings spread across the globe. Side by side, the very fact remains that banking business environment today is more complex compared to even a decade back — being more and more customer-centric and at the same time risk-centric — where efficiency alone or tinkering around the existing strategy skill input levels cannot give the desired level of success. Clearly, from ability comes profitability.

Not only India, but banks in developing countries like Vietnam, Bangladesh, South Africa, Mali or Ghana, have to play a dynamic role as economic development places heavy demand on the resources and ingenuity of the banking system. It has to respond to the multifarious economic needs of a developing country. Traditional views and methods are being steadily replaced. It has been rightly observed that an Institution, such as the banking system, which touches and should touch the lives of millions, has necessarily to be inspired by a larger social purpose and has to subserve national priorities and objectives.

The very nature of banking business today, essentially calls for adapting to continuous fast moving changes — that is to say effectively countering the hurdles, while at the same time ensuring profitability through marketing of the product/service range/value-addition. Especially, in today’s fiercely competitive world, these players have to learn from the past — as well as ongoing experiences — the art of winning over the customer, and at the same time retaining the more demanding customers, through optimum utilization of manpower and technology. Renovating and adaptability to the changing scenario is the arena where the players have to apply more sophisticated service-rendering skills and abilities. And hence the need is there to reinforce the team with renewed updated visions and attitude.

On this score, the challenge comes from two directions mainly — to what extent a bank is employee-customer-centric and risk-centric. In fact the post-Basel II era belongs to banks who could manage the risks effectively. Banks with proper risk management systems would gain competitive advantage by way of lower regulatory capital charge.

Tomorrow will be more challenging

Thus the future is for them who emerge to be top risk managers through optimal utilization of all of the resources — physical, financial, technological and the most important one — the human resource.

Naturally, fixation of strategies, continuous upgradation of skill and making best use of talent backed by effective planning techniques that take care of the forthcoming series of happenings/things, pose the biggest challenge.

In fact, for many of the economies, especially in the developing block, corporate governance is at best at mediocre level. It is high time that the bank boards should understand the risks their institutions are taking. A lack of professional experience in complex risk management issues misled boards into an over-reliance on regulatory compliance and risk metrics that failed to spot unprecedented increase in leverage in the years leading up to the crisis.

Again, any sort of merger-amalgamation process must be goal oriented. The regional rural banks (RRBs) have been merged to form a single entity: has it solved the problem of non-recovery of loans, profitability, employee productivity or best utilization of manpower? Simply asking banks to merge does not serve any purpose if the objectives are impractical. It remains also a fact that privatization alone cannot solve the banking sector’s problems. If the public sector banks go on showing a growth trend why not encourage them?

McKinsey is very right in opining that lenders should also explore new ways to address customers’ needs, especially if they save money. “Both mergers and acquisitions (M&A) as well as partnerships can help them to stay afloat too, especially if they strike deals with fintechs that improve their technology as well as scale,” it said. McKinsey further called upon banks to make “bold late-cycle moves” in preparation for the next recession.

Yes, a prolonged economic slowdown with low or even negative interest rates could wreak further havoc!